BRIT Review

Dr Ed Gouge on the Chancellor's 2016 budget

I think that it was Ken Clarke who said that there are two types of Chancellor of the Exchequer – those who fail and those who get out in time. After the successes of the last two or three years, George Osborne may wish he was now in the Foreign Office, reading unproblematic memos on recent political changes in Angola or the refurbishment of the Embassy in Buenos Aires, rather than putting together a Budget in difficult economic and political circumstances.

It remains to be seen what capital Labour can make out of it. The reply to the Budget speech is made by the Leader of the Opposition and is always a nightmare for the holder of that office as there are only the Chancellor’s key points to react to, while many of the problems are in the Budget documents that can never be analysed in time. Perhaps this is why John McDonnell chose last week to get the headlines by committing Labour to balance the books on the current surplus while borrowing to invest to create growth. More effective is the team at the Institute for Fiscal Studies who are waiting to burrow through the details and their Director can then appear, like a maths teacher looking at a pupil’s homework, and pronounce that the figures do not add up.

The former Governor of the Bank of England, before the 2010 general election, privately commented that a new Government, taking over the nation’s finances, was being given a ‘poisoned chalice’. Despite this the Conservatives won the 2015 general election having succeeded in getting across to voters the political message that it was Labour that caused the economic crisis by spending too much, rather than speculation by the banks.

Critics will point to a poor record in exports. Industrial investment and productivity, but Osborne has presided over economic growth since 2013 and a fall in unemployment. This encouraged him to make the difference with Labour clear by setting a target of reaching a surplus of expenditure over income by the end of this Parliament. He could have taken a step towards this last autumn when the Office for Budget Responsibility decided that he would have £27bn more in tax revenues than expected discovered, as some commentators suggested, ‘ down the back of the sofa’. Instead he decided to use it politically, to reverse the cuts in tax credits that many of his backbenchers were so unhappy about and to slow public expenditure cuts.

Things have changed since the Autumn...

Since last autumn, things have changed. The slowdown in the world economy, particularly in China, and instability in commodity prices put doubts on the level of economic growth and hence in tax receipts. The Chairman of the Office For Budget Responsibility, Robert Chote, has said, rather unhelpfully, ‘what the sofa gives, the sofa can easily give away’. Perhaps the sofa is the OBR’s equivalent of the oracle at Delphi. It hasn’t been very accurate in recent years as the OBR’s original predictions for last year were wage growth of over 5% and inflation of 2%, both way off the mark. To cope with the likely downturn in revenues and maintain the fiscal rectitude he has set for himself the Chancellor should be raising taxes or cutting public expenditure further.

A Government at the beginning of its five year term can generally do unpopular things now and popular things nearer the general election. However, there is the little matter of the EU Referendum, on which not only the fate of the country but also that of Cameron and Osborne depends. They need middle class Conservative votes but also Labour votes to get a Yes vote and so they cannot afford to upset any of these groups in case they are tempted to vote No to get back at the Government. Ken Clarke also said that the voters that lose out in the Budget blame the Government but those that win don’t give the Government any credit. With the Conservative newspapers suspicious of the Government over the Referendum, Osborne may not be able to rely on them to give him the usual laudatory headlines to convince voters that everything is OK.

The first casualty of this political situation has been pensions reform. Tax relief on pension contributions is the same as that for income tax so that higher rate tax payers get 40% relief rather than the 20% that standard rate tax relief payers receive.

Labour, in the election, was proposing to change this for the highest earners and use the money to lower university fees. It is also the situation that people pay tax on a proportion of their pension contributions when they retire so that switching this to taxing people when they pay in to their pension would give the Treasury money now rather than years ahead. Plans to change both these drew criticism from the pensions industry and a threatened revolt by Conservative MPs, Sir Alan Duncan, for example, saying that “Raiding pensions like this destroys people’s planning and I think it will prove very explosive”. All this will now have to wait until next year.

The contenders for raising extra revenue...

The Chancellor has already promised to raise the thresholds for standard and higher income tax payers and the Conservative manifesto gave a commitment not to raise VAT, income tax or National Insurance so there are no easy answers. There are already public expenditure cuts amounting to 1% of GDP in the pipeline so it will not be easy to find more. The areas for extra revenue that have been suggested by economic pundits are:-

-A rise in petrol duty was a source of revenue for Gordon Brown and in periods of prosperity could be justified as a way to combat global warming. With the fall in petrol prices it could be argued that this is an obvious target again but petrol costs are a burden particularly for middle income drivers and Conservative MPs are unhappy about this proposal. Jason McCartney, the Colne Valley MP, has produced a report emphasising the disproportionate effect on rural areas.

-The Chancellor has been cutting beer duty in recent Budgets to try to stem the closure of pubs with CAMRA lobbying hard on the effect any increase would have.

-Capital Gains Tax, charged on items such as shares, second homes, art and jewellery worth over £11,000 already raises more than Inheritance Tax, so the rates on these which vary for standard and higher tax payers could be increased.

-Insurance Premium Tax, which is rather like VAT, is levied on new insurance for homes, pets, vehicles and private medical cover. It has only just been increased in November but could go up again.

-There are the so-called ‘salary sacrifice’ schemes which could be a target for the Chancellor. People receive benefits from employers such as extra holidays or gym membership and, since the employer is paying less wages, they also pay less National Insurance. This would take a while to implement though as employers would need to change all their automated payroll systems.

-People do not pay tax or National Insurance on redundancy payments over £30,000 so this could be changed especially for people with not many years of service.

-There is still some tinkering to be done with pensions, perhaps reducing the amount is not liable to tax.

-There may be money to be found in changes to areas such as Trusts and Investment Bonds which almost no one actually understand except a few tax lawyers and officials in the Treasury.

-There is the good old standby of clamping down on tax avoidance, which can be given a figure which may or may not ever be achieved.

Devolution, business rates and magic tricks...

As a sideshow to the main Budget announcements, Osborne may make announcements on devolution and business rates. The Northern Powerhouse idea involves devolution of spending in areas such as transport and economic development to groups of local authorities with an elected mayor to run these services. Other areas such as Cornwall and the West Midlands also have deals agreed. Below this new tier of government, local authorities have lost so much funding from the Government that they are only really now able to carry out the services that they are required to provide by law and this doesn’t include art galleries, museums, toilets or planning enforcement, for example. They will gradually take over business rates and this and the council tax will be their main source of funding. This is a major recasting of local government. The Chancellor may also announce the results of a review of the business rates system, begun by the Coalition Government just before the general election. Many people think that this property tax, dating from 1572, is no longer fit for purpose. Although at present small firms do not pay, the system taxes retail businesses in town centres disproportionately, whereas a tax on turnover would relate more clearly to the income that businesses receive. The problem is urgent with the British Retail Consortium predicting the loss of 900,000 jobs in retailing and thousands of shops over the next decade.

Although he appears to be boxed in, never underestimate George Osborne’s ability to pull rabbits out of the hat, even if some of them look rather lifeless a few days later. Market interest rates have been falling further so Government borrowing is less expensive. Lloyds shares have been increasing in value so he could sell the remaining ones that the Government holds. He could announce further public expenditure cuts to keep Tory backbenchers happy but backload them to the end of the Parliament in the hope that something will turn up and he won’t actually need to implement them just before the next election. Given all the circumstances this should really be a very quiet Budget but this is a very political Chancellor who wants to be Prime Minister and he may not be able to resist the rabbits.

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